Pension contributions for high earners

Just like everyone else, high earners could benefit from investing in a pension – the tax relief makes pensions a tax-efficient way to invest for later in life. However, high earners need to be aware of how their income and tax band can affect the amount they can contribute to their pensions, and the potential amount of tax relief they can claim.

How much can I contribute to my pension if I’m a high earner?

The usual rule is that you can make pension contributions up to 100% of your yearly earnings or up to the annual allowance of £40,000, whichever is lower. However, if you’re a high earner, and your adjusted income is more than £150,000 a year, the tax relief you can get on contributions is limited to a reduced annual allowance, known as the tapered annual allowance.

Tapered annual allowance

If your threshold income is more than £110,000 and your adjusted income is more than £150,000, your annual allowance for that tax year will be tapered. A tapered allowance reduces proportionally according to your earnings – for every £2 of adjusted income over £150,000, your annual allowance will decrease by £1. The minimum tapered annual allowance is £10,000.

Tax relief on pension contributions for high earners

For most people, pension tax relief comes in the form of government top-ups on any contributions made equivalent to their income for the year, up to the annual allowance of £40,000. Even though this annual allowance is reduced for high earners, you can still benefit from generous tax-relief benefits.

Everybody is entitled to claim the basic 20% tax relief on their contributions. However, because the amount of tax relief you get is linked to the highest band of income tax you pay, higher-rate and additional-rate taxpayers are able to claim extra tax relief on top of the basic 20%. Higher-rate taxpayers can claim a further 20%, while additional-rate taxpayers can claim an extra 25%.

So, if you’re an additional rate taxpayer, even at the minimum tapered annual allowance of £10,000, you could still get tax relief of £4,500 on contributions each tax year. Don’t miss out on these benefits – make sure you claim the additional relief through your tax return.

Carry forward for high earners

Another way to benefit from tax relief is by using carry forward, if your circumstances allow. High earners with reduced annual allowances may still be able to benefit from the carry forward rule:

• you can carry forward any unused annual allowance from the previous three tax years, even if in this year you’ve got a tapered annual allowance
• if you have unused annual allowance from a previous year in which you’ve had a tapered allowance, you can only carry forward an unused amount up to the tapered allowance.

High earners and the lifetime allowance

The government has significantly reduced the lifetime allowance over the past decade. For the 2019/20 tax year, the lifetime allowance is £1,055,000 – if your pension pot exceeds this amount when you start taking from your pension you may have to pay a charge.

If you’re a high earner and you’ve been contributing to your pensions for a while, it’s possible that you may now be close to the lifetime allowance. If this is the case for you, you may want to speak to a financial adviser sooner rather than later to work out what to do with your pension pots.

How do I work out if I have a tapered allowance?

To find out if you have a reduced annual allowance for the tax year, you need to work out your threshold income and adjusted income. In broad terms, your threshold income is your total taxable income excluding pension contributions, while your adjusted income is your total taxable income including all pension contributions.

Your total taxable income usually includes:

• taxable earnings (salary, bonuses, commissions) after salary sacrifice
• dividend payments
• property rental income
• savings income
• profits from self-employment

Threshold income

To calculate your threshold income for a specific tax year, take your total taxable income, add any salary you’ve sacrificed for pension contributions, and subtract any personal pension contributions.

• You’ll need to include any salary you’ve sacrificed for pension contributions if the arrangement started or changed after 8 July 2015 (but you’ll need to check what your arrangement says).
• The personal pension contributions you need to subtract are only those that you have made to a personal or workplace pension – you can’t include employer contributions.
• You may also be able to subtract certain deductions, such as charitable gifts and trade losses. Section 24 of the Income Tax Act 2007 details all the reliefs you can deduct.

If your threshold income for the year is £110,000 or less, your annual allowance won’t be reduced.

If your threshold income is more than £110,000, you need to work out if your adjusted income is more than £150,000 to see if your annual allowance is affected.

Adjusted income

To calculate your adjusted income, take your taxable income for the year, add employer pension contributions and subtract any reliefs that apply.

• If you have a final salary scheme, you’ll also need to include any benefits you’ve built up in that.
• You’ll also need to add any contributions you’ve made to an occupational pension scheme through a net pay arrangement.
• The employer contributions also include any contributions made through salary sacrifice, irrespective of when the arrangement started.

If your adjusted income works out to be more than £150,000, you will have a tapered annual allowance for that tax year: for every £2 of adjusted income over £150,000, your annual allowance will decrease by £1.

The minimum tapered allowance is £10,000, so if your adjusted income is more than £210,000, you will have an annual allowance of £10,000.

If you’re a high earner but you’re not sure whether the tapered annual allowance applies to you, you may want to speak to one of our financial advisers.